BBA Business Organisation Concept of Finance Planning Notes
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Concept of Finance Planning
Concept of Finance : Finance is that activity which involves the estimation, acquisition and administration of funds of any kind used in meeting the needs and objectives of business firms. It is concerned with the procurement and utilization of funds for business.
According to Howard and Upton, “Finance is that administrative area or get or set of administrative functions in an organization which relate to the management of cash and credit, so that the organization may have means to carry out its objectives as satisfactory as possible.”
According to H. Guthman and H. Douggal, “The activity concerned with the planning, raising controlling and administering of funds used in the business.”
Therefore, finance is said to be the life-blood of any business. Finance should be available in adequate quantity to face trade cycles, recessions and other critical times.
Role of Financial Planning
The term financial plans refers to the plan that indicates the requirements of finance, the sources from which, it is to be raised and the application of funds. It is the process of planning the policies, procedures and programmes for effective management of the financial activities of an organization. Financial planning consists of the following activities :
- Estimating the amount of capital required for various needs of business.
- Determining the different sources of finance and the proportion in which they will be used to raise the required capital.
- Formulating the policies for the utilization and administration of funds.
Needs for a Good Financial Planning
Financial Planning is an important part of the overall planning of an enterprise. Sound financial planning is needed for the following:
- Financial planning involves accurate forecast of the present and future capital requirements. Therefore, it helps to avoid the problem of shortage or excess of funds.
- It provides policies and procedures for effective co-ordination between various activities in the business. This hands to elimination of wastage of resources.
- Financial policies serves as broad guides in the effective procurement, allocation, utilization and disbursement of funds. All this is necessary to maintain profitability, solvency and liquidity of business.
- Financial plans enables the management to maintain effective control over the financial operations of the enterprise.
Thus, the success of a business enterprise depends greatly upon sound financial planning.
Characteristics of a Good Financial Plaaning
- Simplicity : A good financial plan should provide a simple financial structure which is easy to manage. If all possible resources of finance are used and different varieties of securities are issued. It may be very difficult to manage the financial structure.
- Flexibility : The financial plan should provide sufficient scope for adjustments in the financial structure. It should permit raising of more-funds to finance expansion and modernization programmes.
- Availability of Adequate Funds : A sound financial plan must ensure the supply of adequate funds to meet both the current and future requirements of business.
- Economy: The funds required by the enterprise should be made available at the minimum possible cost. The composition of total capital should be designed to obtain the most economical financial structure.
- Liquidity: A sound financial plan must ensure a judicious balance between profitability and liquidity. The funds should be so invested that they yield good returns.
- Solvency: The financial plan should ensure the survival and creditworthiness of a business. The burden of fixed charges should be such that the enterprise can pay them in time out of its earnings.
- Optimum use of Funds: A good financial plan is one which ensures the best possible utilization of funds raised from various sources. There should be noddle funds and at the same time funds should be made in the use of business opportunities.
Factors Affecting the Capital Structure
- Trading on Equity : The term ‘equity’ refers to the ownership funds to a company and trading means taking advantage’. Therefore trading on equity implies taking advantage of equity stock to raise fixed change funds at reasonable cost.
- Desire to Retain Control : When the promoters of a company wish to retain control over the company in their own hands, they may raise more funds by issuing preference shares and debentures. The holders of these securities do not enjoy voting right and therefore, there is a little possibility of loss of control.
- Need for Flexibility : It implies the freedom to adopt the capitalization and mix of securities to the changing conditions of the business. Equity shares take the capital structure rigid as they cannot generally be paid back before winding up of the company.
- Nature of Business : Companies enjoying regular and liberal earnings, e.g., public utilities, can afford to have high capital gearing. On the other hand, business firms which are subject to wide fluctuations in demand and earning may find it safer to depend more on equity capital and preference shares.
- Cost of Financing : In a good financial structure the cost of capital should be reasonably low. Cost of financial includes the interest on dividend to be paid and the administrative expenses of issuing a particular type of security.
- Capital Market Conditions : The general state of capital market influences the choice of securities to be issued. During boom, investors are willing to take risk and invest in equity shares. But in a bearish market or downswing, investor prefer safe investment.
- Statutory Requirements : Banking companies are prohibited from issuing any type of security, eycite equity shares. Government of India has also laid down ceilings on public deposits and the ratio between capital and debt.
- Period of Finance : Generally, permanent of long term capital is raised through equity share and preference shares medium term funds can better be raised through redeemable preference shares or debentures.
- Purpose of Finance : if funds are to be raised for modernization, expansion and other purposes, that will add to the earnings of the firm debentures and long term debt can be used.
- Assets Structure : The choice of securities should be appropriate to the liquidity and composition of assets. The cash flows of the company must be sufficient to meet the changes for funds.
Long Term Finance Sources
- Issue of Shares : The owned capital of a company is divided into a large number of small equal parts. Each such part is known as share. A company can issue two types of securities :
- Debentures : Debentures denote borrowing by a company and represent its loan capital. Debenture holders are the creditors of the company. A debenture is a document or certificate issued by a company as a proof of the money but to it by the holder.
- Underwriting : When a company makes an issue of shares or debentures, it is not quite sure that public will subscribe for the entire issue. In order to ensuftens the entire issue is sold out, it makes an arrangement known as underwriting with a financial.
- Ploughing Back of Profit (Self Financing) : Retained earnings represent that portion of a company’s net profit which is kept in business for investment purpose and not distributed among the shareholders as dividend. This is also called self financing.
- Institutional Financing : The government has set-up a number of special financial institutions in the country to provide long-term finance to business enterprise. The IFCI, IDBI, ICICI,SFC are the main among such financial institutions.
- Public Deposits : It implies any money received by a non-banking company by way of deposit or loan from the public including the employees, customers and shareholders of the company, other than in the form of shares and debentures.
- Hire Purchase : Hire purchase is a type of instalment credit under which the high purchaser, called the hirer, agree to take goods on hire at a stated mental, which is inclusive of the repayment of principal as well as the interest, with an option of purchase,
Importance of Financial Planning
- Successful Promotion: Effective financial planning ensures successful promotion of the business which is only is only possible through well thought out flexible financial plan drafted in anticipation of the establishment of the business.
- Effective Direction: Business operations require funds. The successful operation of a business depends on adequate and timely availability of finance for the promotion of business, purchase of assets and raw materials, production and marketing of goods. Thus, the success or failure of a firm is closely linked with financial planning.
- Conservation of Capital: Sound financial planning is necessary for the effective utilization of capital. Plant and machinery acquired by an enterprise become obsolete soon after the arrival of new machinery in the market with improved technology. Thus, sound financial planning is inevitable for conservation of capital investment in assets.
- Expansion and Development: The objective of a business enterprise is profit-maximization. This requires the expansion and development of the business unit for achieving its optimum operational efficiency. Efficient financial planning eliminates financial planning is inevitable for the conservation of capital investment in assets.
- Adequate Liquidity: Efficient financial planning makes the firm capable of maintaining adequate liquid funds to meet its obligations to the creditors. Availability of adequate liquid funds prevent the firm from the situation of over-trading and strengthens its repayment capacity.
- Adequate Return on Capital Employed: Sound financial planning leads to the effective utilization of capital by avoiding both under-capitalization and over-capitalization both of which are harmful to the financial interests of a corporation. Thus, efficient financial planning leads to a higher return on capital employed by the firm.
- Optimal capital structure at Minimum Cost: Efficient financial planning leads to the optimal capital structures of the firm at a minimum cost. In deciding the ratio of different forms of capital in the total capital of the firm, the financial manager ensures that the firm pays the least cost and incurs less risk. After analyzing the costs and risks involved in different forms of capital, he finally selects those which involve the least cost without much risk.
- Unity and Co-ordination in Operative Functions: Financial planning leads to the most effective utilization of the firm’s capital by establishing ineffective co-ordination in different operative functions and unity in action by all executives at different levels. Thus, it serves as a guide to effective coordination among various operative functions and unity in action. At different levels, the executives follow financial policies, procedures, and objectives as set out in the financial plan.